in Annuity on February 9, 2023
Among financial pundits today, Dave Ramsey certainly has a large following and has helped people with various areas of personal finance, such as getting out of debt. Millions tune into his radio show. That being said, Ramsey has very strong opinions on annuities. The question is whether his anti-annuity stances are on the mark.
While opinions are subjective, Dave Ramsey has been incorrect on the facts of annuities that he discusses on occasion on his show. In some cases, the inaccuracy has been notable.
For retirees needing a guaranteed lifetime income stream, guaranteed growth above what bonds or other fixed-interest assets offer, and other guaranteed benefits from an annuity for their goals, it’s a huge disservice to completely disregard these options as part of a retirement strategy. Just as millions of listeners turn to Ramsey for how to get out of debt, millions of people have benefited from having an annuity in their retirement financial plan.
One issue with Ramsey’s annuity positions is that annuities come in all sorts of flavors, just as mutual funds do. Each type of annuity has different strengths, downsides, and benefits in what they can offer. It’s a straw-man argument to group them all together as being the same.
While this isn’t meant to be exhaustive, here are a few instances where Dave has it wrong on annuities — especially fixed index annuities — and how keeping annuities as a serious consideration in retirement planning is better for the public.
Annuities Aren’t Good for a Long Retirement
Quincy asked Dave Ramsey on Facebook whether “annuities are good for long-term retirement.” Ramsey’s answer was an emphatic “No.”
This is precisely what annuities are built for. Since they have maturity periods that last for a certain timespan, they are a long-term commitment. Annuities are a worthy option to consider if you are looking for tax-deferred growth, protection of your principal while still having interest-earning opportunities, and benefit of a guaranteed lifetime retirement income.
By writing them off as a long-term instrument, Dave is going against the very best purpose that annuities are designed for: satisfying long-term retirement needs, whether it’s accumulating money or paying a long-term income stream.
Current generations of retirees are living longer than past generations did. That means greater risk for running out of money in retirement. Annuities are the only financial vehicle besides Social Security that will pay a steady income stream for as long as you may live.
Using Annuities to Accumulate Savings
Back in 2020, in response to a Texas caller asking about whether annuities are a option for accumulating savings, Ramsey said this:
“There are two types of annuities, Lex. There’s an annuity that is a fixed annuity, which I never recommend. The fixed annuity has basically a money market-type interest rate of one, two, or three percent right now. If you could get three percent it would be a great day. And it’s basically a savings account with an insurance company. They put a lot of fees on them, and they’re horrible. It’s like putting money into a CD as a long-term investment.”
There are a number of misstatements in this one. First of all, there aren’t two types of annuities, but five kinds that we discuss here at SafeMoney.com: fixed, variable, multi-year guarantee, immediate, and fixed index.
Nor do fixed annuities have a history of paying out money-market-like interest rates. Their guaranteed rates tend to be higher than those of money market products. The average money market rate was 0.372% at that point in January 2020, according to data from MagnifyMoney.
The interest rate in fixed annuities is guaranteed for a certain period. At that same point in 2020, fixed annuities were paying between 1.75% and 3.5%, depending on the length of annuity term.
Most fixed annuities don’t have “a lot of fees put on them,” but rather are low cost or don’t have any fees at all. Nor should fixed annuities be evaluated as an investment or called that. They are a fixed-type insurance product from a life insurance company. They also can pay out a guaranteed income for as long as you need it, which no investment can duplicate.
Annuities and… Savings Accounts?
Chris, a caller, asked Dave Ramsey about different options for retirement wealth accumulation. Ramsey gave this in response:
“You could also do annuities. There are fixed annuities and variable annuities. I would not do fixed annuities because they are a bad savings account with an insurance company. A variable annuity gives you some access to mutual funds and allows them to grow without paying taxes on them.”
Speaking of an annuity as a “bad savings account” falls short in many ways. Savings accounts generally pay paltry interest, they can’t offer you a guaranteed lifetime income as annuities can, and their tax treatment is different from annuities.
An annuity is treated as a retirement-saving vehicle under the IRS code. The money you put into the annuity is tax-deferred, and the dollars you earn from the money growing in the annuity also have tax-deferred treatment. Keep in mind that withdrawals from the annuity will be taxable as ordinary income.
Nor does Dave Ramsey mention fixed index annuities here as an alternative for those looking for higher growth potential but still having protection for their principal. With a fixed index annuity, your interest earnings aren’t guaranteed as they are with a fixed annuity.
However, the fixed index annuity is tied to an underlying benchmark index, and you can earn interest based on a portion of the index’s gains when that index goes up. When the index goes down, your principal and already-credited interest are protected. Growth potential is capped with this type of annuity, but that is a trade-off for the protection in times of index losses.
Annuities and Agent Commissions
Kathy, a caller, made too much money for a Roth IRA account, which Ramsey regularly promotes for retirement saving. She asked Ramsey about a variable annuity that her financial advisor has recommended. His answer:
“A variable annuity has some neat features, one of which is tax-deferred growth. Another feature that’s not so neat is that your financial person will make 2 or 3 times the commission that they would make on a typical mutual fund sale, so they tend to be drawn toward variable annuities.”
While we don’t talk about variable annuities as much here, this isn’t true of variable annuity commissions. According to TheBalance.com, commissions on variable annuities can range from 4-7%. This isn’t to say that some variable contracts don’t pay higher than that. However, it’s not necessarily the norm.
Mutual funds, on the other hand, might actually fall into this commission range, depending on the type of mutual fund you buy. Mutual funds that are “Class A” or “Class B” will charge some sort of “load” as a commission to the fund’s managers.
Class A funds have a “front-load” commission, meaning that a percentage of the initial balance you put into the fund is shaved off for commission payment to the fund manager.
On the other hand, Class B funds have a “back-load” commission, meaning a percentage of the balance that you earn when you sell shares will go as a commission to the fund’s managers.
Depending on the financial company from which you buy mutual fund shares, you might pay as high as a 5% commission. Of course, this isn’t the case for all mutual funds, as you pay for some simply with annual fees. But it just goes to show how saying a variable annuity commission is “2 to 3 times” a mutual fund commission is well, well out of range.
And what about those pesky fixed index annuities? While many pundits love to talk about their “double-digit commissions,” very few actually pay this.
In fact, according to multiple market intelligence sources, less than 1% of total annuities sold each year have a double-digit commission. That means that a very small minority of annuity sales qualify for that overinflated claim.
With fixed index annuities and fixed annuities, the entire sum of money you put into the contract goes to work for you. So if you put in $250,000, your starting contract value in the annuity will be $250,000. The insurance company pays the agent from its own coffers.
Growth with a Fixed Annuity vs. Mutual Funds
In an article about annuities on Dave’s website, Chris Hogan, an associate of Ramsey Solutions, talked about fixed annuities and mutual funds.
“Fixed annuities are basically a savings account with an insurance company. They’re similar to a certificate of deposit (CD) you can find at most banks… I’m just going to tell you right now that fixed annuities aren’t worth your time. If you’re saving up for retirement, the rate of return that fixed annuities offer just won’t cut it. You can do much better than that with good growth stock mutual funds. Stay away!”
Fixed annuities and mutual funds aren’t an apples-to-apples comparison. A fixed annuity is intended to have growth potential above that of fixed-interest investments, such as bonds, CDs, and other such vehicles. In fact, they can be part of an overall retirement strategy that balances out the risk of market loss that mutual funds hold.
They can be a valuable tool for diversification, and typically fixed-type annuities are treated as part of the fixed-income/safe interest-earning part of a retirement plan. (Not a risky, growth-driven part like mutual funds.)
As has been said many times already, a fixed annuity can also pay you a guaranteed income for life, just as an annuity can. Mutual funds don’t have this ability.
Annuities and Access to Your Money
This also comes from the same annuity article, referenced above, by Chris Hogan of Ramsey Solutions. Hogan wrote:
“These [SafeMoney.com editor’s addition: surrender charges] can really trip you up if you’re not paying attention. Most insurance companies set a limit on how much you can take out for the first several years after you buy an annuity, called the “surrender charge period.” You’ll be charged a fee on any money taken out beyond that limit, and those charges can cost you a pretty penny. And that’s on top of the 10% tax penalty if you take out your money before age 59 ½!”
There is no mention here of free withdrawals of up to 10% of an annuity’s contract value. These free withdrawals are permitted to give contract owners some access to their money should they need it. Some fixed-type annuity contracts even allow for cumulative free withdrawals of more than 10% of your contract value if you don’t withdraw money for the first few years in.
It’s good to know that any withdrawals are taxable as income, and if your annuity money is of pre-tax status, withdrawals before 59.5 will incur a 10% early withdrawal penalty.
Annuity Fees and Charges
In the same annuity article, Hogan served up an entire menu of fees that come in annuity contracts. However, it’s mostly variable annuities that carry these fees that he mentioned, below.
“Insurance charges: These might show up as a ‘mortality and expense risk charge.’ Basically, these charges cover the risk the insurance company takes on when they give you an annuity, and they’re usually 1.25% of your account balance per year.”
“Investment management fees: These are just what they sound like. It costs money to manage mutual funds, and these fees cover those costs.”
“Rider charges: Some annuities offer extra features that you can add to your annuity—things like long-term care insurance and future income guarantees. These extra features are called ‘riders,’ and they’re not free. There’s a fee for those riders, too.”
Some fixed index annuities do have riders which are add-on benefits to the contract. Because they are an add-on, those riders might have an additional fee. But the vast majority of fixed-type annuities, and even many fixed index annuities, don’t have these charges as Hogan describes. Insurance charges, investment management fees, and various rider fees tend to tied mostly to variable annuities.
Naturally, this is one of the most common arguments against annuities. Hogan should have distinguished between fee-laden variable annuities and fixed-type annuities in this article. This can be off-putting to people who might have been attracted to a fixed annuity or a fixed index annuity for their financial goals otherwise.
Using Retirement Funds to Start an Annuity
In the same annuity article, Hogan said this:
“And I want you to hear me loud and clear: Annuities are not a replacement for traditional tax-advantaged retirement vehicles. Never put a retirement account that already has tax advantages into an annuity. You don’t get any extra tax benefits from putting a 401(k) or IRA into an annuity—only more fees. Pass!”
What is troublesome about this claim is that tax-advantaged retirement accounts are most people accumulate money for retirement. From 401(k) plans and 403(b) plans to IRAs, most people are building up funds for retirement in these types of tax-advantaged accounts.
Most people actually start annuities with money from these accounts or plans because that is where most of their money is. They want a guaranteed lifetime income, protection of their principal, a guaranteed growth rate, or other benefits that the annuity can give them. The financial products in their current retirement account aren’t giving them a certain benefit that the annuity will provide.
Since they wish to keep the tax-advantaged treatment of their retirement funds, they will transfer or roll over their qualified workplace retirement plan or IRA money into a new retirement account. The annuity would be inside the new retirement account, so telling people to avoid annuities because they don’t bring additional tax advantage is missing the point.
Again, the annuity offers something that the financial products in their current workplace retirement plan or IRA simply aren’t fulfilling.
Could You Benefit from an Annuity as Part of Your Retirement Strategy?
Dave Ramsey, Chris Hogan, and other team members from the Ramsey platform have helped many people in a number of ways, especially in getting out of debt. But that doesn’t mean that their financial guidance is accurate on everything.
As we have seen here, there are many occasions on which their anti-annuity pronouncements fall short (just as Ken Fisher does). That ultimately leaves people with fewer choices for retirement — fewer choices that can help them reach their goals with contractual guarantees.
If you are looking for someone to help you start exploring these options for your retirement, you might consider an independent financial professional. They aren’t beholden to one insurance company or financial company in general. Being independent means that they have the business freedom to offer products from multiple companies, which ultimately means more options that can be a solution for your situation and goals.
Here at SafeMoney.com, many independent and experienced financial professionals who understand annuities are available to assist you. Get started by using our “Find a Financial Professional” section, where you can connect with someone directly. You can request an initial appointment at no cost to discuss your goals, concerns, and financial situation. Should you need a personal referral, please call us at 877.476.9723.
